The “Halvening” Explained

The Bitcoin Blockchain is the distributed transaction ledger that records every bitcoin transaction that has ever taken place. The ledger is secured using cryptography. Transactions are bundled together in the form of “blocks” and miners around the world compete to add these blocks to the blockchain. To add a block to the chain they have to do a lot of repetitive calculations of sha256sum hashes. If they succeed to find the right hash they get to add a block of transactions to the chain.

Block Subsidy

Their reward for this work is the block subsidy or block reward as well as the transaction fees for all the transactions in the block that they’ve added to the chain. The block subsidy or block reward consists of new bitcoins that are generated each time a block is added to the Blockchain and the miners get to keep these bitcoins.

Initially the block subsidy was 50 bitcoins. Every 4 years or so that subsidy halves. It’s currently at 25 bitcoins per block. After about 5000 more blocks (~35 days) it will halve again to 12.5 bitcoins per block. In this manner the number of new bitcoins that are created goes down over time in a predictable manner. Since bitcoins can “only” be divided to 8 decimal places at some point it won’t be possible to halve the block subsidy and no new bitcoins will be generated after that. This is what makes bitcoin a deflationary currency that is capped at 21 million bitcoins.

Difficulty: The other side of the coin

With the advancement of computer technology the amount of computer power you can buy for a certain amount of money increases over time. So to counter that the bitcoin blockchain automatically increases the “difficulty” level that is the level of computing resources you have to devote to mine a block. Difficulty changes roughly once every 2 weeks and the algorithm is designed to adjust difficulty so as to keep the average time between blocks to 10 minutes.  So difficulty is a related to the total network hash rate i.e. the total computing resources devoted by miners around the world to mining bitcoin.

A higher difficulty adds to the cost miners face in mining new blocks. A lower difficulty reduces their costs. Big increases in difficulty can cause machines that were previously profitable to no longer be profitable and miners can take those offline. Similarly large decreases in difficulty can cause previously unprofitable machines to be brought online.

It is possible that the halvening of the block reward will cause miners to take down some machines and this will cause a significant enough change in the network hash rate that difficulty goes down. Some say this will not happen because the whole halvening schedule is known in advance and miners will have planned their investments accordingly.

The current and historical difficulty numbers can be found here.

Impact of halvening on the bitcoin price

The impact of the block subsidy or block reward halvening is evident in the recent price rises. The price is rising because the supply of new bitcoins is going to go down after the halvening. Whether the price will continue to go up in the short term is not known. In the long term the price can only go up because of the deflationary nature of the currency.

Hat tip to Alex

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